J.P. Morgan Retirement Leader Examines Sequence of Returns Risk in TDF Context

The latest though leadership from the firm asks an increasingly important question: “What should the TDF glide path look like as participants move from accumulating asset balances to spending down those balances in retirement?”

Talking through the 2018 Guide to Retirement with a small group of financial services trade journalists, Anne Lester, head of retirement solutions for J.P. Morgan Asset Management, highlighted the deep analytical work her team has done regarding the optimal shape of target-date fund (TDF) glide paths during investors’ retirement years.

This is a subject of renewed attention among asset managers, defined contribution (DC) plan sponsors and their advisers and consultants, Lester said. And this is for good reason, as “waves of retiring Baby Boomers are foregoing paychecks for plan payments—distributions from DC plan balances accumulated during their working lives.”

Lester recounted a commonly told but important story. Until really the last decade or so, DC plans were a nice-to-have supplement to defined benefit (DB) pension plans. Today, for many members of the U.S. workforce, they are a critical source of retirement income that will need to be spent down carefully and with ongoing diligence. Additionally, Lester noted that more than 75% of DC plans with qualified default investment alternatives (QDIAs) have chosen a TDF as their default offering.

With all of this in mind, it is easy to see why the topic of how well target-date funds serve investors near and in retirement is increasingly prevalent. One of the first questions Lester advocates asking is, “What should the glide path look like as participants move from accumulating asset balances to spending down those balances in retirement?” And, the related question will come up, “Should the allocation to equity risk assets continue to decline, increase or plateau?”

The J.P. Morgan view, under Lester’s leadership, is that the allocation to equity risk assets should gradually decline through the working years, reaching its lowest point at or near retirement and remaining static in retirement. Interestingly, Lester explained that her team has come to agree with independent academic research that shows some theoretical merit to re-risking later in retirement from a mathematical/portfolio theory perspective. But she also talked about how behavioral constraints have to be considered here, arguing her firm’s approach takes an appropriate middle ground, balancing the capacity for risk in retirement with the willingness/cognitive ability to take risk effectively.

“We take the stresses of real-life participant saving and withdrawal behavior into account, and we rely on well-diversified glide paths to manage a range of participant-experienced risks associated with DC investing,” Lester explained. These include market, event, longevity, inflation and interest rate risks.

Lester says the firm has recently focused on understanding the behaviors of near-retirement and in-retirement clients. In doing so, the firm incorporated a sizable dataset from Chase on household spending, including the near-retirement years, supplementing the data on participant behavior that has traditionally informed glide path design. In addition, the firm seeks to “quantify and evaluate the implications of two opposing dynamics: the willingness and the capacity to take on risk during retirement.”

“Our latest analyses further validate our thinking on glide path design,” Lester said.

Lester pointed to recent J.P. Morgan research penned by her asset management colleagues Daniel Oldroyd, Katherine Santiago, Marissa Rose, and Livia Wu. As their analysis shows, as participants transition from the accumulation to the decumulation phase, the potential adverse effects of a market downturn on total lifetime wealth reach their peak. Simply put, as net spending continues to deplete balances, it becomes more and more difficult to recover from market losses, even with stronger returns in the later retirement years.

Further impacting glide path decisions is the fact that participant cash flows “are more volatile and varied in the near-retirement years than one might think,” Lester warned.

“Our earlier research on participant withdrawals showed that 14% of those over age 59 ½ withdraw, on average, 30% of their DC plan assets,” the researchers explain. “This volatility can intensify the risks associated with a market downturn near retirement if large spending withdrawals result in assets being liquidated at reduced valuations.”

The latest findings using Chase data on spending validates the team’s initial assumptions, Lester said. Spending in the near-retirement years is volatile and varied, “to a degree that can’t be ignored when structuring glide path allocations in this critical period.”

Another interested factor pointed out by the J.P. Morgan research team is that “average returns in retirement matter far less than the sequence of those returns.” As Lester summarized it, poor performance in the early (vs. later) years can have a far more destructive impact on a portfolio’s ending value.